Commentary / World

What throws a monkey wrench in trade talks

by Kazuhito Yamashita

Concerning the United Kingdom’s exit from the European Union, there are views that the chances of a no-deal Brexit will remain even if the Conservatives win the Dec. 12 general election.

Even after the Brexit deal agreed on between British Prime Minister Boris Johnson and the EU is approved by Parliament and takes effect Jan. 31, the theories go, the talks for a free trade pact that will define future relations between Britain and the EU will need to be concluded by the end of the transition period through the end of 2020. In the case they fail to do so, the U.K. and the EU will face January 2021 without an accord that define their trade relations, creating a state of no-deal Brexit.

The Financial Times on Nov. 22 noted that while Johnson and Phil Hogan, the EU’s new trade commissioner, believe the negotiations next year will not require much time because Britain has been an EU member for 46 years, a senior official of the European Commission says the talks will be a difficult process for the U.K. since it has little experience in trade negotiations — and that other EU members will likely call on the commission to take a tough position toward Britain.

The FT quotes Michel Barnier, the EU’s chief Brexit negotiator, as saying that the further Britain departs from the EU rules, the more its access to the EU market will be restricted. Should the U.K. adopt regulations on the protection of workers and the environment that are looser than the EU’s rules, British products will become more competitive.

Therefore the EU will likely call on Britain to adopt regulations similar to the EU rules — just like the United States often demands a level playing field in its trade negotiations. However, such tight restrictions may leave the U.K. wondering why it is departing the EU in the first place, since Brexit is all about regaining sovereignty from Brussels so it can freely set its own legal rules.

As for financial services, there is a mechanism called the single passport, which allows a financial services provider to freely operate anywhere within the European Economic Area (EEA) — comprising 31 countries including the EU members and some others — as long as it has won approval in any EEA member state. Because of this system, many financial institutions keep their bases of European business operations in the City of London.

However, it remains to be seen if Britain can continue to benefit from the system following its departure from the EU. Free trade agreements concluded by the EU demand equivalence assessment in financial services — meaning that the EU will grant access to its market only to countries that have regulations equivalent to the EU rules.

At issue will be whether the EU will determine whether Britain’s financial system is equivalent to that of the EU.

Aside from the free trade negotiations, the FT also reports that continued access to Britain’s fishery waters will be a top priority for EU members such as France, Spain and Denmark, which have operated in those areas, and that they will strongly make that case in talks with the U.K.

Concerning the case for the level playing field, it will be impossible to demand a sovereign state to keep adopting EU rules indefinitely in the future. They will likely agree on a deal similar to the chapters on trade and labor as well as trade and environment in the North American Free Trade Agreement or the Trans-Pacific Partnership. If I were in Johnson’s shoes, I would point out that the EU has not required equivalent regulations in its free trade pact with Japan.

Liberalization of the services trade are based on two principles: the principle of most-favored nation, in which the same level of access will be granted as provided to other countries, and the principle of national treatment, which accords the same treatment as guaranteed to domestic companies.

The EU grants a single-passport system to nonmembers Iceland, Lichtenstein and Norway. Britain will be able to demand most-favored nation status and the national treatment as long as it maintains financial regulations equivalent to that of the EU.

As for the euro business, many financial institutions have already moved their operations from London to continental Europe in light of Brexit.

What’s more important is that the various fields in free trade negotiations — liberalization in the movement of goods, services trade, intellectual property rights, investments and so on — will ultimately be agreed on in a package even if they are separately negotiated in the process. The EU will be in a position to determine whether to grant Britain access to the financial services market, while they stand in opposite positions as to access to Britain’s fishery waters. Should the EU take a tough stance toward Britain over financial services, the U.K. may fight back in the fisheries talks.

People may think that financial services will be disproportionate to fisheries in terms of their economic scale. But what makes an area of trade negotiation crucial is not its economic size but its political importance.

Historically, agriculture has been the core sticking point in trade negotiations. In the Uruguay Round negotiations under the General Agreement on Tariffs and Trade, which paved the way for creation of the World Trade Organization, negotiations on agricultural trade were the most difficult and required the longest amount of time. The Uruguay Round would not have reached a conclusion had the U.S. and the EU failed to reach an agreement on agriculture.

U.S. President Donald Trump called on Japan to hold bilateral trade negotiations because U.S. farm products became less competitive against Australian and Canadian exports in the Japanese market when the TPP-11 pact came into effect. The EU was earlier cautious toward a free trade pact with Japan but became more willing to strike a deal after Japan joined the TPP talks because it feared that European farm products would face disadvantages in the Japanese market. Free trade negotiations between the EU and the U.S. have yet to start — despite the earlier promise made by then European Commission President Jean-Claude Juncker to Trump to hold such talks in an attempt to avert additional U.S. tariffs on automobiles — because France refuses to include farm products among the targets of the negotiation.

Today, agriculture, forestry and fisheries industries make up a tiny portion of the economy of major industrialized countries. Those sectors combined account for 1.2 percent of Japan’s gross domestic product, 1.6 percent of that of France — where agriculture is said to be the largest among EU members — 0.6 percent of Britain’s and 0.9 percent of the GDP of the U.S., the world’s largest exporter of farm products. Even in Australia, their share of the economy comes to a mere 2.6 percent.

Trade negotiations become complicated not because the sectors at stake make up a large portion of the economy, or due to technical difficulties in resolving the problem. The share of agriculture in each economy is generally small, and negotiations over farm products are often quite simple: how far to push down the import tariffs or expand the import quotas. Still, agriculture has been the most important area of trade negotiations because agriculture is politically important for the countries involved.

Each country sets its own limits to liberalizing farm trade due to domestic political considerations. Trade negotiations become difficult when an agricultural exporter demands access to the importer’s market beyond the latter’s line of defense that is allowable in terms of maintaining its own agricultural output. The talks get complicated because it requires a vast amount of time and energy for both parties to adjust their respective interests — such as persuading their domestic industries to accept concessions — before an agreement is reached.

Trade talks are easy if the sectors at stake are not politically important. In its talks with Japan, the Trump administration did not demand greater access to the rice market because California, which exports rice to Japan, is a blue state — a traditional stronghold of the Democrats. Similarly, if Johnson determines that London is not a Conservative stronghold, financial services may not be a major point of contention in the talks with the EU. On the other hand, fisheries have been a major issue in EU politics.

Not just Barnier but people like Juncker and Donald Tusk, the former president of the European Council, did not think of Brexit as a favorable development. The reported remarks by Barnier and senior members of the European Commission predicting tough negotiations ahead and hinting at the likelihood of a no-deal Brexit — made just as the campaign is going on for an election in which Brexit is the key issue — may indeed have hidden intentions.

Kazuhito Yamashita is research director of Canon Institute for Global Studies and a senior fellow of the Research Institute of Economy, Trade and Industry.